Beware investment contracts if euro breaks

By: Jonathan Boyd | 20 Jan 2012

Courts in EU member states could be tested to breaking point by any moves to solve the euro sovereign debt crisis by ending Greece’s – any other member state’s – use of the currency, according to analysis from financial lawyers K&L Gates.

From a legal perspective, the currency union faces a matrix of outcomes dependent on whether there is a partial or complete breakup of the eurozone, and whether any breakup is deemed legal or illegal under EU treaties and other laws.

Redenomination as per local currency laws or apply conversion rates of ECU-2

Obligations governed by foreign law

Redenomination into new national currency (via local law unless not in interest of relevant foreign country)

Source: K&L Gates

The challenge to investors is that because of the competing principles of contract law, EU treaties, and the law of money – Lex Monetae – courts could force contracts to be met in either local currency or euros.

Should the euro move closer towards a breakup, then investors may face questions such as:

– What will happen to euro share classes in funds?

– Does manager remuneration require renegotiation if it is currently based on outperforming Euribor rates?

– How should derivatives contracts priced in euros be handled?

Lex Monetae would become crucial in any contract disputes becuse it outlines key principles that courts in different jurisdictions already rely on, according to Alice Bell, assistant at K&L Gates London.

This law means countries have sovereignty over their own monetary systems. This affects contracts because it means sovereign states can freely declare the replacement of one currency by another, and force monetary obligations to be redenominated into the new currency.

“If a monetary obligation refers to a particular currency, the law of the country where that currency is used will determine what currency payment is to be made in, regardless of the governing law of the contract.”

“This is an English legal principle but is internationally recognised and has been followed by courts in multiple jurisdictions when considering currency changes introduced by independent states over the years,” said Bell.

“As a result of the Lex Monetae principle, monetary obligations can never simply cease to exist but must be replaced by a new unit of account or currency.”